Why You Should Reconsider This Once-Troubled Retailer

Tim Begany's picture

Friday, March 11, 2016 - 12:30pm

by Tim Begany

A word of advice to investors who remain leery of Target Corp. (NYSE: TGT): Set aside any lingering doubts and get back into the stock. Target's on the mend after recent setbacks.

I'm referring, of course, to the discount retail giant's infamous 2013 security breach that exposed the credit card data of some 70 million customers. Also that year, Target kicked off what would prove to be a brief, poorly executed attempt at Canadian expansion. That ended abruptly early last year with a $5.4 billion write-down and roughly $2 billion in net losses.

All this crushed the bottom line, with Target posting more than a $1.6-billion net loss in the 12 months ended January 31, 2015 versus a $3-billion profit two years earlier. Target's stock was in or near bear territory during much of these turbulent times and the firm's image suffered, putting management in the unenviable position of having to win back both customers and investors.

But much has changed since then. Under new CEO Brian Cornell, a three-decade retail and consumer products veteran who took command right in the middle of the tumult, Target and its stock are executing a decisive turnaround.

One key move: divesting the company-owned pharmacies operating within most of Target's 1,800 U.S. locations. They were losing money, despite combined annual revenue of $4 billion.

Last June, however, Target announced the sale of its pharmacies to CVS Health Corp. (NYSE: CVS), which expects to have them all under the CVS banner this year (and soon turning a profit). For Target, the deal generated a $1.9-billion cash infusion, as well as a close association with a leading name in health and wellness.

Without the pharmacies or the failed Canadian expansion draining resources, management's free to focus on the profitability of core U.S. operations. To that end, it's scrambling to improve e-commerce capabilities, which have long lagged those of main rival Wal-Mart Stores (NYSE: WMT).

Last year, spending on e-commerce-related initiatives like website upgrades, better mobile shopping apps and supply chain improvements totaled $1.4 billion, making 2015 the first year ever that Target put more toward e-commerce than new stores and remodels. It's planning on $1.8 billion in e-commerce investment this year, followed by at least $2 billion a year thereafter.

However, Target intends to keep growing its physical footprint, with plans to open 11 new locations this year and four in 2017. Most of these will be a tenth to a third the size of the traditional big-box locations, which are normally around 120,000 square feet. The smaller stores are well-suited for densely populated urban areas with ample disposable income such as Boston, Los Angeles and Chicago, where a big-box format is apt to be impractical.

At all locations, management will stress "signature" product categories -- style (fashion), infants, kids and wellness. Target offers greater variety in these popular categories than Wal-Mart, which leans more toward lower-margin food and grocery items, and they'll be a crucial differentiator going forward.

Strong Rebound
According to Target's Feb. 24 earnings release, comparable sales growth averaged a sturdy 1.9% companywide in the fourth quarter, thanks to especially robust demand for signature products. This marked Target's fifth straight quarter of rising comps, though quarterly sales were down slightly because of lost pharmacy revenue. 

Still, total revenue climbed nearly 2% to $73.8 billion in the 12 months ended January 31 on rapid improvement in e-commerce sales, like Q4's 34% increase (versus Wal-Mart's 8% gain). Target's net profit during that time was a $3.4 billion, an impressive rebound from the prior year's $1.6 billion loss. At almost 7%, operating margins are at their highest level since 2013.

In the coming year, management sees comps climbing as much as 2.5% overall, whereas Wal-Mart is expected to deliver a mere 0.5% comps growth. Ongoing restructuring efforts and the absence of the unprofitable pharmacy and Canadian operations should nicely boost margins.

Management's guidance also calls for an 11%-to-15% gain in full-year adjusted earnings to $5.20-to-$5.40 a share. In the long-term, management expects earnings to compound around 10% annually, similar to the 11% growth rate analysts are forecasting for the next five years. 

As for the 2013 data breach, it ultimately cost Target relatively little -- only around $100 million in legal and other costs after insurance reimbursements and tax deductible losses. Plus, recent financial performance suggests the situation has largely blown over. Of course, it helps that management is accepting responsibility, shoring up security and equipping stores with credit card machines that accept the new EMV chip-protected cards.

Risks To Consider: Competition is fierce, not only from Wal-Mart but also from national grocery chain Kroger (NYSE: KR), leading discounter Costco Wholesale (NYSE: COST) and online retail behemoth Amazon.com (Nasdaq: AMZN). Thus, Target can ill-afford any further slip-ups.

Action To Take: Even with its Canadian setback and huge data breach still in the rearview mirror, Target isn't quite out of the woods. But it's well on its way, and I'm confident the recent rebound sets the stage for years of solid profits. Clearly, Wall Street is, too, as Target's stock is up about 12% this year, compared with the S&P 500's roughly 2% year-to-date loss.

Yet shares of Target are still attractively valued, with a trailing price-to-earnings ratio of 15.3 and a forward P/E of only 14. Historically, Target sells for around 17 times earnings. A 2.8% dividend yield only adds to the appeal of its compelling turnaround.

P.S. We're locking in a paycheck of $15,100 for every $100,000 we invest... and our dividends keep growing... sometimes overtaking our original stock price. Invest like this and it just might change the way you think about investing forever.

Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.